Chengdu Leejun Industrial (SZSE:002651) has had a great run on the share market with its stock up by a significant 16% over the last week. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Specifically, we decided to study Chengdu Leejun Industrial's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Chengdu Leejun Industrial is:

4.4% = CN¥121m ÷ CN¥2.8b (Based on the trailing twelve months to December 2023).

The 'return' is the yearly profit. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.04.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company's earnings growth potential. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Chengdu Leejun Industrial's Earnings Growth And 4.4% ROE

It is hard to argue that Chengdu Leejun Industrial's ROE is much good in and of itself. Even compared to the average industry ROE of 7.4%, the company's ROE is quite dismal. Chengdu Leejun Industrial was still able to see a decent net income growth of 9.2% over the past five years. We reckon that there could be other factors at play here. Such as - high earnings retention or an efficient management in place.

We then performed a comparison between Chengdu Leejun Industrial's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 11% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Chengdu Leejun Industrial is trading on a high P/E or a low P/E, relative to its industry.

Is Chengdu Leejun Industrial Using Its Retained Earnings Effectively?

With a three-year median payout ratio of 31% (implying that the company retains 69% of its profits), it seems that Chengdu Leejun Industrial is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Moreover, Chengdu Leejun Industrial is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.

Summary

Overall, we feel that Chengdu Leejun Industrial certainly does have some positive factors to consider. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard would have the 2 risks we have identified for Chengdu Leejun Industrial.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.